Should insolvency code be amended to protect home buyers?

Experts say that instead of amending the Insolvency and Bankruptcy Code (IBC), which is a general law, the best approach will be to amend the sectoral law, which in this case is the RERA

ByVandana Ramnani

The government is considering amending the Insolvency and Bankruptcy Code (IBC) to protect the interests of home buyers who have invested their savings to buy a house. There are two options before it – amend the bankruptcy law to ensure that buyers get their due and not lose out to banks and financial institutions when a defaulting builder’s properties are liquidated and debts settled or to change the law’s operational rules to make home buyers trustees so that their investments are mandatorily protected.

IBC versus RERA

Some experts agree that the insolvency law is the most effective mechanism available to resolve distress situations and that some cracks in the law can be amended to address issues faced by stakeholders. “A few safeguards for home buyers need to be built in,” they say. However, there are other analysts who believe that instead of amending the IBC, which is a general law, the best approach will be to amend the sectoral law, which in this case is the Real Estate (Regulation and Development) Act, 2016 (RERA).

“A specific amendment to the IBC code could just create an interpretational issue and may lead to many classes/sectors demanding such amendments. Other laws such as the RERA can be amended to provide a better framework governing developers,” says Param Pandya, Research Fellow in the Corporate Law and Financial Regulation Vertical at Vidhi Centre for Legal Policy.

What this means is that IBC is a general law and is applicable to all sectors. Apart from real estate firms, automobile companies also take an advance for booking a vehicle, so should insolvency law provide an exception for them too?

“One has to be careful about amending the IBC, providing for a general exception and not providing amendments for a specific sector. Therefore, amending IBC for every sector may not be ideal, it may only make a general law get too complicated,” says Pratik Datta, a public policy researcher.

So, IBC should be sector neutral. Therefore, the next best option is to amend the central RERA to include a provision that escrow account is kept outside the liquidation and insolvency estate, he suggests.

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“The escrow account provision in which 70 per cent of the amount is set aside for construction could be amended to say that the amount set aside in an escrow will be outside the purview of the insolvency resolution professional in the event of the company becoming insolvent,” he says.

But there is a downside to this too. Not all sectors can utilise money given as advance by consumers as working capital and that may have serious implications on the business model. “In case of a telecom company, it is not necessary that the company will use the funds collected from consumers to build towers as the basic infrastructure is usually in place before the service is rendered to a customer. While telecom firms may afford to keep the amounts collected from consumers in a separate fund, it may not be the case for real estate companies where amounts collected from buyers are used as working capital to construct buildings. If the escrow account provision in RERA is amended to state that the advance funds or pre deposits collected from home buyers should be bankruptcy remote, the business model of the sector may also have to be altered as developers depend on the advances collected from home buyers for construction purposes,” he says.

Should buyers seek secured creditors’ status

Homebuyers who had bought apartments and plots in projects by Jaypee Infratech against which the National Company Law Tribunal (NCLT) has started insolvency proceedings are seeking the status of secured creditors like banks as well as being made a party to the insolvency proceedings. During proceedings in the Supreme Court this week, lawyers representing Jaypee home buyers resisted any suggestion that kept them out of the resolution process. "We are financial creditors. Jaypee owes us Rs 15,000 crore, more than what it owes IDBI. They can't have a resolution plan without us. We must be part of it," senior advocate Ajit Sinha argued on their behalf. Senior advocate P Chidambaram, appearing for some associations of home buyers, also urged the court to treat home buyers as financial creditors.

The chief justice of India also agreed. "This is a citizenry problem, a human problem of great magnitude. IDBI can't be selfish. The home buyers have invested their lifetime savings in these projects," the CJI said and the court appointed Shekhar Naphade, senior counsel and Shubhangi Tuli, advocate on record, to participate in the meetings of the insolvency resolution professional and support the cause of home buyers. "Be it clarified that we have passed this order keeping in view the provisions of the Act (Insolvency and Bankruptcy Code, 2016) and also the interest of the home buyers," the court said in its order.

Buyers have been asking for Section 53 to be amended to provide them secured creditors’ status because they figure low in the creditors’ order for payment of dues under the Insolvency and Bankruptcy Code (IBC). IBC rules (Section 53) lay down that in case the defaulting builder’s properties are liquidated, the proceeds must first be used to recover liquidation costs, pay workmen such as security guards, wages and any unpaid dues owed to employees other than workmen, settle the dues of banks and financial institutions, pay the salaries of other employees and clear government dues. Homebuyers come only towards the end of this list, which means that by the time their turn comes, there might be nothing left of the proceeds to settle their dues.

“If home buyers are brought under the category of financial creditors, then in case the company/developer is declared insolvent and a resolution professional is appointed, homebuyers can participate in the resolution process thereby making their voices heard. They will be placed higher than non-financial unsecured creditors,” says Pandya.

Sitesh Mukherjee, who heads the dispute resolution practice at Trilegal, says that as long as homebuyers get a priority above secured creditors, their interests are safeguarded. In case of insolvency, the land, assets are worth something and sufficient to at least get home buyers the money with interest.

There’s yet another view to this. Datta says that even if buyers are elevated to the position of financial creditors or secured creditors at par with banks, their assets are not fully protected. Banks are in the business of disbursing loans and in the process are taking a risk. If buyers are brought at par with banks they may have to bear a similar risk. "Buyers should instead demand a third party status or treatment as third party trustee wherein their funds are bankruptcy remote and not merged with those who are on under the committee of creditors."

Most buyers pay the real estate developer in advance for delivery of the property at a future date. The problem begins when the developer defaults in delivering the property on time. Buyers resort to various legal actions either to get possession of the property or to get their money back. Clearly, in these cases, the buyers are not creditors of the realty company. They are merely consumers of its services. Just like a pre-paid mobile customer is a consumer of the telco, he says.

In one exceptional case - Nikhil Mehta v. AMR Infrastructure - NCLAT held the concerned flat buyers to be "financial creditors". But this was because of an exceptional clause in their agreement. The developer had contractually agreed to pay a monthly amount to the buyers till the property was delivered to them. In view of this unique clause, NCLAT held that these flat buyers were "financial creditors" of the developer company. This is not a principle of general applicability. Therefore, it can be concluded that all flat buyers are consumers but not necessarily financial creditors.

It could be legitimately argued that the funds and properties held by the insolvent real estate company in trust for the third party consumers (flat buyers) should get the protection under section 36. In that case, these funds and properties cannot be taken away by the creditors (like banks) of the real estate company, he says.

Section 36 of IBC refers to assets held in trust for third party trustees. “The following shall not be included in the liquidation estate assets and shall not be used for recovery in the liquidation:— (a) assets owned by a third party which are in possession of the corporate debtor, including— (i) assets held in trust for any third party; (ii) bailment contracts…”

Experts also point out that changes in section 53 of the code will require an amendment, which will take time. But elevating home buyers to a new category of trustees could be done through a notification.

The Jaypee story so far

The Jaypee Infratech case involving almost 40,000 homebuyers was a unique case because other companies that were taken up under the Insolvency and Bankruptcy Code were business-to-business firms such as steel and power companies but Jaypee Infratech involved thousands of home buyers. Also, this week the Supreme Court has lifted the stay on the insolvency resolution proceedings against ailing real estate firm Jaypee Infratech and reinstated the National Company Law Tribunal-appointed insolvency resolution professional (IRP) Anuj Jain asking him to submit an interim plan to the apex court within 45 days. It also ordered JP Associates, the parent company, to deposit Rs 2000 crore before the Supreme Court by October 27.